As interest rates reach their highest level in over 20 years and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are reserves set aside by banks to manage potential losses from credit risks, including defaults on loans and delinquent debts.
JPMorgan allocated $3.05 billion for credit losses during the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion, more than tripling its prior quarter’s reserve, and Wells Fargo reported provisions of $1.24 billion.
These increases in reserves indicate that banks are preparing for a more challenging financial environment where both secured and unsecured loans pose greater risks. A recent analysis by the New York Fed revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as individuals draw down on savings accumulated during the pandemic and rely more heavily on credit. For the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder balances exceeded this threshold. Meanwhile, the commercial real estate sector also faces significant challenges.
“We’re still emerging from the COVID period, and much of that is influenced by the stimulus provided to consumers,” commented Brian Mulberry, a client portfolio manager at Zacks Investment Management.
The potential challenges for banks may become more apparent in the coming months. “The provisions recorded in any given quarter reflect banks’ expectations about future credit quality rather than just the last three months,” explained Mark Narron, a senior director with Fitch Ratings.
He noted a shift from a historical system where loan defaults would increase provisions, to a framework where macroeconomic forecasts dictate these reserves. Currently, banks are predicting slower economic growth, a rising unemployment rate, and two expected interest rate cuts later this year, which may lead to higher delinquency and default rates by year-end.
Citi’s chief financial officer, Mark Mason, highlighted concerns primarily affecting lower-income consumers, whose savings have diminished since the pandemic. He noted that only customers in the highest income quartile have managed to increase their savings since 2019, with growth in spending and high payment rates largely coming from those with higher credit scores. Conversely, those in lower credit score brackets are facing declining payment rates and increasing borrowing, significantly affected by heightened inflation and interest rates.
The Federal Reserve’s interest rates remain high, set at 5.25-5.5%, as they await signs of inflation stabilizing towards the central bank’s 2% target before making any cuts.
Despite banks’ caution regarding potential defaults in the latter part of the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is monitoring the distinction between homeowners and renters during this period. Homeowners generally locked in low fixed rates, which have shielded them from significant financial distress, while renters face challenges due to drastically increased rental costs.
Rent prices have surged over 30% nationwide from 2019 to 2023, alongside a 25% rise in grocery costs during the same time. Renters who did not secure low rates are feeling the strain of rising rental prices outpacing wage growth.
Currently, industry experts suggest that recent earnings reports reveal no major changes in asset quality. Strong revenues, profits, and robust net interest income are positive signs for the banking sector’s health. “There is still strength within the banking sector, which although not completely surprising, is reassuring given the solid structuring of the financial system,” Mulberry noted, while cautioning that sustained high interest rates could lead to increased stress.